When the Federal Reserve's Open Market Committee met in mid-March, it had a lot of new developments to consider. Since it had met in January, unrest erupted in the Middle East. Oil and food prices had begun rising quite rapidly. A devastating earthquake hit Japan that shook Asian markets. Finally, the unemployment rate appeared to be declining significantly, while rising consumer confidence continued to boost spending. How do economists synthesize all of these contradictory signals? The FOMC's meeting minutes show the nation's top central bankers citing increased uncertainty, which led to differing views of what the future holds.

Inflation

Some debate appears to have broken out about inflation. While most Americans probably believe prices are rising, based on gasoline and food prices, the consensus view at the Fed is that these changes won't lead to higher overall inflation in the long-term. Most Fed economists believe that commodities have increased in price just temporarily. Those rising prices have shifted some shorter-term inflation expectations in the market, but longer-term expectations remained stable.

Not everyone was on the same page, however:

A number of participants noted that, with significant slack in resource utilization and with longer-term inflation expectations stable, underlying inflation likely would remain subdued for some time. However, the importance of resource slack as a factor influencing inflation was debated. Some participants pointed to research indicating that measures of slack were useful in predicting inflation. Others argued that, historically, such measures were only modestly helpful in explaining large movements in inflation; one noted the 2003-04 episode in which core inflation rose rapidly over a few quarters even though there appeared to be substantial resource slack.

In other words, some committee members believed that current market conditions would not produce higher inflation, despite the increased prices of commodities. But others disagreed. This is a big economic question, so it should warrant some controversy.

Exit Strategy

Some Fed economists have reduced their GDP growth estimates, according to the minutes. It calls these changes modest, but they suggest that the confidence these committee members had in the recovery has been somewhat shaken by recent events and the lack of very robust growth in early 2011. Does the more pessimistic outlook strengthen the possibility of another round of monetary stimulus? Not necessarily.

Some members of the committee aren't even convinced that the current quantitative easing program is helping:

Specifically, the Committee maintained its existing policy of reinvesting principal payments from its securities holdings and reaffirmed its intention to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011. A few members remained uncertain about the benefits of the asset purchase program but judged that making changes to the program at this time was not appropriate.

In other words, a few members don't like it, but they think it would be worse to shake up the market by ending it prematurely than allowing it to take its course. Yet it's hard to believe that these members will vote in favor of a third round of quantitative easing, unless the economy deteriorates significantly over the next couple of months.

So when might we see the Fed begin a campaign of monetary tightening? That may depend on inflation expectations. The minutes discuss the risk of the market potentially perceiving that the Fed's balance sheet has grown too large:

To mitigate such risks, participants agreed that the Committee would continue its planning for the eventual exit from the current, exceptionally accommodative stance of monetary policy. In light of uncertainty about the economic outlook, it was seen as prudent to consider possible exit strategies for a range of potential economic outcomes. A few participants indicated that economic conditions might warrant a move toward less-accommodative monetary policy this year; a few others noted that exceptional policy accommodation could be appropriate beyond 2011.

We could see the Fed begin reducing the amount of money in the financial system as early as this year if those "few participants" have their way. Again, the urgency with which the Fed executes its policy will probably depend on two factors: whether inflation expectations begin to rise and if the economic recovery continues on a stable path.

After about six months of relatively boring Fed meetings, things should begin to heat up in June. At that time, the Fed will have additional information on the recovery's status in 2011, whether oil prices are still stubbornly increasing, and how much global shocks of affected the U.S. economy. It will then have to decide to either initiate another round of monetary stimulus or begin withdrawing some of the massive support it has provided over the past three years. Those are two very different choices, and last month's minutes show that Fed economists may disagree on which strategy to follow.

About the Author

Daniel Indiviglio was an associate editor at The Atlantic from 2009 through 2011. He is now the Washington, D.C.-based columnist for Reuters Breakingviews. He is also a 2011 Robert Novak Journalism Fellow through the Phillips Foundation.

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